What has the European Commission proposed?
The European Commission has proposed a directive to guarantee a minimum effective global tax rate of 15% for large groups operating in the European Union. agreement reached by the OECD / G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS). The proposal sets out how the effective tax rate will be calculated by jurisdiction and includes clear, legally binding rules that will ensure that large EU groups pay a minimum rate of 15% for each jurisdiction in which they operate.
Where does this proposal come from?
Minimum corporate taxation is one of two lines of work agreed upon by members of the Organization for Economic Co-operation and Development (OECD) / Inclusive Framework of the G20, a task force of 141 countries and jurisdictions that have come together focused on the two-pillar approach to address the tax challenges of the digital economy. They worked on a consensual global solution to reform the international corporate tax framework, which resulted in a global agreement between 137 jurisdictions in October 2021. Discussions focused on two main themes: Pillar 1, Reallocation partial tax rights; and pillar 2, the minimum level of taxation of the profits of multinational enterprises.
As promised, the European Commission is now implementing pillar 2 of the global deal, making effective minimum global corporate taxation a reality for large group companies located in the EU.
Who do the rules apply to?
The proposed rules will apply to any large group, both national and international, including the financial sector, with combined financial income of more than 750 million euros per year, and with a parent company or a subsidiary located in a EU member state.
Which entities do not fall within the scope of the rules?
In accordance with the inclusive OECD / G20 framework agreement, government entities, international or non-profit organizations, pension funds or investment funds which are the parent entities of a multinational group will not fall under the scope. application of the OECD Pillar 2 Directive. is because these entities are generally exempt from corporate income tax in order to preserve a specific policy outcome. This may be because the entity is performing governmental / quasi-governmental functions, or to ensure that funds or pensions do not risk double taxation.
How will the effective tax rate be calculated?
The effective tax rate is established by jurisdiction by dividing the taxes paid by entities in the jurisdiction by their income. If the effective tax rate of entities in a given jurisdiction is below the minimum of 15%, then Pillar 2 rules are triggered and the group must pay additional tax to raise its rate to 15%. This additional tax is known as the “income inclusion rule”. This supplement applies whether or not the subsidiary is located in a country that is a signatory to the OECD / G20 international agreement.
Who will do the calculations?
In the inclusive OECD / G20 framework agreement, a transparent method of calculating the effective tax rate has been agreed by the 137 countries concerned. This is reflected in the proposal for a directive. Calculations will be made by the ultimate parent entity of the group unless the group affects another entity.
What happens if a group is based in a non-EU country where the minimum tax rate is not applied?
If the overall minimum rate is not imposed by a non-EU country in which a group entity is based, Member States will apply what is known as the “under-taxed payments rule”. This is a backstop rule to the primary income inclusion rule. This means that a Member State will effectively collect part of the additional tax due at the level of the whole group if certain jurisdictions where the entities of the group are based impose a level below the minimum level and do not impose any additional tax. The amount of additional tax that a Member State will collect from group entities in its territory is determined via a formula based on employees and assets.
Are there any exceptions?
The rules provide for the exclusion of minimum income amounts to reduce the burden of compliance. This means that when the income and profits in a jurisdiction are less than a certain minimum amount, no additional tax will be charged on the group profits made in that jurisdiction, even when the effective tax rate is less than 15%. . This is known as the de minimis exclusion.
In addition, companies will be able to exclude from additional tax an amount of income which represents at least 5% of the value of tangible fixed assets and 5% of the wage bill. This is called a “carve-out substance”.
The political rationale for a substantive exclusion is to exclude a fixed amount of income related to substantive activities such as buildings and people. This is a common aspect of corporate tax policies around the world, which seeks to encourage investment in economic substance by multinational companies in a particular jurisdiction. This exclusion also focuses rules on excess income, such as that related to intangible assets, which are more sensitive to tax planning.
The agreement excludes from the scope of application income earned in international shipping, as this particular industry is subject to special tax rules. Special characteristics such as the capital-intensive nature, the level of profitability and the long economic life cycle of international maritime transport have led a number of jurisdictions to introduce alternative tax regimes for this sector. The widespread availability of these alternative tax regimes means that international shipping often operates outside the scope of corporate tax.
These exclusions will not distort the calculations of the effective tax rate.
Is there a transition period for the exclusion of substances?
For the first 10 years, there is a transitional rule that the exclusion of substance starts at 8% of the book value of the tangible fixed assets and at 10% of the labor costs. For tangible fixed assets, the rate decreases annually by 0.2% for the first five years and by 0.4% for the remaining period. In the case of the wage bill, the rate decreases annually by 0.2% for the first five years and by 0.8% for the remaining period.
Is the EU proposal different from the OECD Model Rules?
The Commission proposal follows closely the international agreement with the necessary adjustments to ensure compliance with EU law and without gold plating.
The Directive will therefore adjust the scope to also include purely national groups, while the scope of OECD Pillar 2 is limited to multinational groups (MNEs) and a parent entity only subjects its foreign subsidiaries to the income inclusion rule. This derogation from the OECD model rules is necessary to comply with the fundamental freedoms of the EU, in particular the freedom of establishment.
The OECD Model Rules allow jurisdictions to apply a qualifying national minimum tax. The Commission proposal will also allow EU Member States to exercise the possibility of applying a national additional tax to weakly taxed national subsidiaries. This option will allow the additional tax due by the subsidiaries of the multinational group to be invoiced at the local level, within the respective Member State, and not at the level of the parent entity.
What happens if some non-EU countries do not apply the OECD rules?
Within the OECD / inclusive framework, the rules have been agreed in what is known as a “common approach”. This would mean that members of the Inclusive Framework are not required to adopt the rules, but if they choose to do so, they will need to implement and administer the rules in a manner consistent with the outcome agreed under Pillar 2. It also means that Members of the Inclusive Framework will have to accept that other members apply the rules. In practice, multinational groups with subsidiaries in countries that apply a rate lower than the agreed minimum rate will ultimately also have to deal with the consequences of Pillar 2. Indeed, the rules test the effective tax rate by jurisdiction. and apply a top-up tax to businesses in low-tax jurisdictions. Due to the income inclusion rule or the under-taxed payments rule, a member state will collect additional tax due at the level of the whole group if certain jurisdictions in which entities are based impose a lower tax. at the minimum level and not impose any additional national tax.
In other words, failure to apply the Pillar 2 rules will not protect jurisdictions from being effectively subject to tax at least at the agreed minimum rate.
How does this fit into the broader agenda of the Commission?
The Commission has a broad program to ensure fairness and transparency in corporate taxation. The Commission Communication on Business Taxation for the 21st Century, adopted on 18 May 2021, outlines a comprehensive vision for business taxation in the EU, taking the EU forward to establish a European framework for taxation companies capable of meeting the challenges of the 21st century and geared towards a well-functioning single market. The measures announced in this Communication as well as the measures announced in the Tax Action Plan for Fair and Simple Taxation adopted in July 2020 will complement the directives proposed today and contribute to greater tax transparency in the EU. In addition, by 2023 the Commission will propose a New Framework for Business Taxation in the EU (BEFIT) to create a stronger but also more business-friendly environment in the Single Market.
What are the next legislative steps?
Member States will have to agree unanimously in the Council. The European Parliament and the European Economic and Social Committee will also have to be consulted and give their opinion.
Importantly, EU members of the OECD Inclusive Framework already support the global deal that the Commission proposal implements. The only EU member state that is not a member of the inclusive framework and, as such, has not formally committed to the agreement, is Cyprus. However, we expect Cyprus to support the directive.